This post draws attention to a problem with the nature of public finance accounting which comes in the way of public financing of essential infrastructure projects.
Consider the following infrastructure requirements - piped rural and urban water supply, sewerage treatment and solid waste management facilities, municipal and village roads, rural connecting roads, state highways, storm water drains and cleaning of urban canals, school and hospital buildings etc.
Aside from a few, the vast majority of these assets have limited or no revenue generation. But it's also widely accepted that not only do these investments enhance productivity in individuals and the economy, but they are also basic public goods and essential requirements for dignified life. In fact, one would argue that for a country aspiring to be a $5 trillion economy, potable drinking water supply, basic public health, connected habitations and population centres, paved streets, disease breeding and clogged drains and canals, schools and hospitals with basic facilities are a minimum requirement.
The conventional wisdom on infrastructure financing is that in case of revenue generating assets, establish special purpose vehicles, transfer the asset to its balance sheet, put in some equity including by way of the land or site, mobilise debt by escrowing future revenue streams, undertake construction, and repay from the escrow. Wherever possible, it encouraged that this be done through the likes of public private partnerships.
In case of infrastructure assets without or with limited revenue stream, the suggested financing source is from the budget. Since these is little or no revenue generation, raising project debt is ruled out. Therefore, to the extent that revenue receipts are equity, such projects are expected to be financed with equity.
However such budget financing has hard constraints. In fact, after excluding human resource expenditure and debt financing, a few universal subsidies (food and electricity) and welfare schemes (pensions, agriculture etc), repairs and assets maintenance, and the state government shares for the Central Sector Schemes (CSS), the budget resource remaining for capital expenditures is tiny. This applies to almost all states in India.
It's just about sufficient to meet the requirements of a few roads and community assets, if at all. In the circumstances, very few state governments can ever hope to undertake large mandates like saturation of the state with any of those mentioned earlier even over a period of five years using budget finance alone. Five trillion dollar economy or not, we will need decades to fulfil even the basic public goods requirements!
So we have an infrastructure financing problem. On the one hand, even though these projects do not directly generate revenues, they are undoubtedly productivity enhancing and therefore expands the economy's production possibility frontiers and thereby increase the economic output and generate revenues for the government. In fact, there is a strong case that given the low baseline, these investments are low hanging fruits with high marginal productivity and incremental output increases, and thereby high multipliers.
On the other hand, the public finance accounting limitation that recognises only direct revenues means that governments cannot raise debt for projects without direct revenues but with high indirect economic multipliers. In other words, governments cannot do what the private sector does in routine course - raise debt to finance projects which increases aggregate revenues. In a purely Econ 101 sense, this inability to use debt to supplement budget equity for projects that raise aggregate output and revenues of the government is an inefficiency. While the private sector leverages debt to finance its capital expenditures, governments are restrained from doing the same by its accounting conventions!
How can this paradox be addressed?
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